With the slowdown in China's economic growth claiming headline casualties from sellers of luxury goods to shipping companies, a new report says the debt problems of a less visible victim the Chinese steel trader could impact China's banks.

According to the report, produced by Bernstein Research, the problem began, as do so many financial bubbles with plentiful cash. As in other corners of the commodity world, Chinese steel traders, who can get bank loans pledged against their steel inventory, availed themselves of the easy credit that came from the construction led, stimulus induced boom China enjoyed in the aftermath of the financial crisis.

But many weren't prudent in how they acquired or used the loans, according to Bernstein. The traders, particularly those in the Shanghai and Yangtze River delta region, began to secure credit by pledging nonexistent collateral or by pledging the same steel inventory multiple times.

In one case, Bernstein said, traders went to great lengths to disguise the fraud.

One unidentified banker told Bernstein analysts that "Our bank sent a group of people to Zhejiang province to investigate the problem. They went to a warehouse to check the steel inventories pledged with our bank. Much to their surprise, only the top layer of the stack was steel. Beneath the top layer was filled with nothing but sand."

Bernstein didn't name any banks or traders involved in the fraud in its report.

A news department official at the China Banking Regulatory Commission said the commission was monitoring the issue, but didn’t immediately offer further comment.

An official at the China Iron and Steel Association, which has jurisdiction over steel businesses, said the quasi governmental body is aware of the allegations. Deputy secretary general Mr Chi Jingdong said he couldn't ascertain if the abuses were widely prevalent but said the association believes there have been such occurrences of fraudulent loans. Mr Chi said he wasn't aware if the association has conducted a detailed probe yet.

In some cases, the report says, traders plowed the loans into gambles on equity markets, as steel sales alone weren't sufficient to cover interest payments. As the stock markets slowed and steel prices fell to record lows, the traders got caught in the receding tide. Banks began to choke off credit, spurred by a directive in April 2012 from the China Banking Regulatory Commission to stamp out the steel fraud.

The shakeout among steel traders is ongoing. Bernstein said its survey of steel traders along the Bohai Sea coast and Guangzhou indicated that only about half of contracted orders for steel products in September were fulfilled. It added that "This number should be 100% in normal times and averaged 70% from July to September 2012, according to a large steel trader in Guangzhou."

The report said that the danger from loans made to steel traders is not spread evenly throughout China's banking sector. For large banks, nonperforming loans made to steel traders on average amount to less than 0.5% of total loans. For smaller banks, however, exposure is 2% to 4%.